One of the most gratifying aspects of writing is reading the comments and, on occasion, being able to answer a question or two. Some of the best material is in the comments section.

The Simple Path, and indeed the blog itself, grew out of a letter I wrote to my then 19-year-old daughter. She doesn’t share my fascination with finance and investing. Most people don’t. But in this modern world of ours, money is crucial. I wanted her, and now you, to have simple but highly effective investing tools. The ideas here are designed to provide a lifetime of successful investing with minimal effort and cost. They are for those who have better things to do with their time. The cool thing is, that when it comes to investing, the correct minimal effort actually produces better results than labor intensive strategies.

Of late I’ve been toying with the idea of a post that showed what rolling out and living with this approach might look like. All I needed was to create a fictional young investor about to begin their journey. That’s when reader KLR saved me the effort and provided the motivation by posting a comment/question here.

For the purposes of this post, I emailed KLR with some follow-up questions. I’ve taken the liberty of adding his responses into his original note below, but all the words are his.

His note and my reply follow.

“Jim,

I stumbled onto your blog this week and have caught up with all your money posts. I would like to say that your guidance has probably saved me months of research and lots of frustration. Thank you for the great topics, but I am now trying to figure out my plan and my head is spinning.

I’m 26 and have recently graduated from college, and decided to get my financial life in order. Luckily, I was able to find a great job and have no debt. I am working on saving up my emergency fund (roughly 24% of my income is going into it) and now focusing my efforts on investments.

I was also lucky that my grandparents seeded an investment fund for all of the grandchildren when each was born. It has been managed by a financial advisor for years, and your posts have confirmed my thoughts that I can do better. It currently has around $35,000 in it in 12 different mutual funds.

I talked to my grandmother and she doesn’t remember the exact amount that started my account. Whenever a new grandchild was born, she would put a starting amount in equal to what was in the older children’s accounts. The earliest records I have is from 1994. At the start of that year, there was approx. $6700 in the account and a $1000 was added by my grandparents each year until the it hit around $25,000. In 1994, the funds were half stocks and half bonds (my grandfather grew up during the great depression and didn’t really trust full stocks).

Next June, I will be eligible to enter my employer’s 403(b) plan and also a pension plan. I am able to put 3% of my income into the 403(b) plan and they match with 2.5%. It looks like I will be able to enroll in Vanguard’s total stock market index fund. There is also an optional traditional IRA plan that I can contribute up to the maximum allowed by the IRS. It seems that after learning more about all of this, the 5.5% of my yearly salary into my 403(b) is nowhere the maximum allowed by the IRS, which is a little discouraging.

I make $70k per year before taxes. Right now I’m saving 24% of my pay. My goal is to keep it at 20% or more, but realize I might have to drop to 15% if other commitments arise. I haven’t really thought about when I want to retire. It would be great to retire early, but I have not officially set that goal yet. I just know it is important to get everything lined up to get ready for retirement and that is what I am trying to do now.

I don’t think I’m going to do the optional IRA account and instead do a Roth IRA on my own. What is your suggestion on getting rid of my financial manager and all the mutual funds and buying into VTSAX? I don’t fully understand the tax implications that are involved in that. Correct me if I’m wrong, but $5000 would go into the Roth and the rest into a traditional account. I think I know the answer, but do you think it is fine to have the investments in my 403(b), Roth IRA, and my regular account in VTSAX?

What is the best way to contribute to my funds? After I get my emergency fund built up and my money transferred to vanguard, I will have around $1000 per month. Do I put that in each month or wait to put in larger amounts. I have heard of dollar cost averaging, but haven’t looked into it too much. Thanks again for your advice and time.

Sorry for the long post, but any assistance would be greatly appreciated.

Thanks

KLR”

He also kindly added a link to his employer’s benefits page, but asked that his employer’s name remain confidential. Looking at that page, what he refers to in his note as “an optional traditional IRA plan” is an SRP.

Welcome KLR….

….glad you found your way here and delighted to hear you’ve found some value. Plus you’ve given me a great opportunity for another post!

You mentioned that you’ve read thru the money posts so we can go forward assuming that base of knowledge. For those newer readers following along I’ll provide links to some relevant posts, as I did above.

But before we get started, some congratulations are in order. No, not for you.

For your grandparents!!

They deserve big time major league kudos. Please tell them I said so.

The fact that they have provided this seed capital for you and their other grandchildren tells me several things. They have resources, and that means they are fiscally responsible and effective in their own lives. They are generous. And, considering your questions and plans, clearly they have passed it on to their descendants. If you haven’t already, take them out to dinner and raise a toast in their honor. Even if you have, do it again.

2. 70k salary and you are saving 24% (17k annually) of that for your emergency fund.

3. You want to target saving about 20% going forward, or 14K. I’ll try to persuade you to increase that.

4. You’ve landed a good job with an employer that provides some excellent retirement plan options.

5. No debt.

6. You’re not sure about retirement yet, no surprise at age 26, but you recognize the importance of F-You Money. We’ll focus on getting you there.

7. You want to know how to contribute to your investments going forward and about Dollar Cost Averaging.

Mmmm. Looking at that list, you deserve some kudos too!

Let’s talk first about what investment to choose.

Fortunately, with your employer’s benefits plan Vanguard is an option.

You are leaning toward Vanguard’s Total Stock Market Index Fund and you are spot on. This is where we’ll put all of your investments. You are in the Wealth Building phase of your life and this is the right tool for the job.

There are three options to owning this fund: Admiral Shares, Investor Shares and as an ETF (Exchange Traded Fund). VTSAX is the Admiral version and provides the lowest cost, but has a 10k minimum. Investor Shares, VTSMX, holds the same stocks, but with slightly higher costs and a 3k minimum. Use Admiral whenever you can and Investor if you need to as a start. You can switch to Admiral when you clear the 10k hurtle.

This one fund will give you a portfolio that owns virtually every publicly traded company in the USA. Since many of these have extensive international operations, you also have international market exposure. With this one investment you’ll have broad diversification in the most powerful wealth building asset of all: Stocks. This allocation of 100% stocks is considered a very aggressive and that’s what we want for this phase. But be warned, as you know from reading my series on stocks you can expect a wild and gut wrench ride. But you’re going to stick to your plan, keep investing and tough it out. You have decades ahead.

At some point you’ll start thinking about retirement.

Maybe when you’re 65 or maybe when you have F-you money around 35 or so. Whenever the time comes, as you approach that phase you’ll want to consider diversifying into other asset classes. This is where Mrs. jlcollinsnh and I are in our lives and I’ve written about what we own and why we own it. But right now you are in the wealth building phase. Stocks are where you want your money and VTSAX is how you want to own them.

Next let’s look at the variousInvestment Bucketsyou have available and discuss how to allocate your VTSAX investment. Basically you have four and in each will be a separate account, all invested in VTSAX/VTSMX. In order of desirability they are:

1. 403 (b). Since you work for a university you have a 403 (b) and your employer had the wisdom to engage Vanguard as one of the plan providers. (Readers working for companies have much the same but it is called a 401k.) You’ll contribute 3% of your salary, which will be tax deferred, and your employer matches 2.5%. That’s free money! That makes this option #1.

Since your total for the first year will be about $3850 you’ll probably start with VTSMX, but check. Because it is a 403 (b) plan, and by definition long-term investment money, Vanguard might waive the 10k minimum for VTSAX.

2. Roth IRA. You should put the maximum allowed into your Roth each year: $5000. While you get no immediate tax deduction with a Roth, when you retire all distributions are tax free. That includes everything your Roth earns over the decades. Very cool deal. Everyone should have a Roth, especially when you are young and in a low tax bracket. Rather than using part of your 35k stake, I suggested you fund your Roth with money from your earnings. You’ll be doing this every year.

3. SRP (Suplemental Retirement Program). This is an additional program your employer offers and the IRS allows you to contribute up to $17,000 each year. No company match, but you get a tax deferral on the contribution. It is a very attractive benefit.

4. Ordinary Bucket. This is what I call regular investments made outside any tax advantaged bucket like the first three. You’ll pay taxes on the dividends and capital gains distributions but, unlike tax advantaged accounts, your money is available anytime with no penalty. This is where your 35k is now and when you move it to VTSAX that will still be the case.

When you sell the 12 funds you currently own, assuming they have appreciated in value, you will owe a capital gains tax. Don’t lose sleep over this. Cap gains taxes are low at the moment.

A bit later we’ll talk about how much goes into which bucket, but first…

…let’s discuss a couple of things:

1. Your savings rate is currently 24% as you are building your emergency fund, and you plan to reduce this to 20%. Compared to the average American these percents are excellent. Compared to where you want to be, you should consider doing more. 50% is my suggestion, but others more committed to having F-you money commonly reach for 70-80%.

You are already stepping out of the norm by being debt free, saving and investing. You are employed, young and childless. Never will you be in a stronger position to take it to the next level. At the very least, avoid “lifestyle inflation” by pledging that any salary increases will go towards your investments. Do this now and in the future your problem will be how to spend all the money your money earns for you.

2. Your emergency fund, if you are following standard investment advice, is likely too large. Keeping a few grand around is fine, but if you are trying for six months of income (35k in your case) you are tying up money that should be working harder for you.

OK, with all that under our belt let’s run some numbers and look at specifics.

Option #1, 24% savings rate.

You start with the $35,000 from your grand parents. Move that immediately into VTSAX. Pay the cap gain tax, if any. On average over time the market returns 10-11% annually. At that rate your money doubles about every 7 years. By the time you are 61 it will have doubled 5 times. A quick back of the envelope calculation shows you’ll have around $1,120,000. Without adding a single penny. Wait till you’re 68 and it’s $2,240,000. That’s the power of compounding. Did I mention you should take your grandparents to dinner?

If you add to it as you go along, as you’re going to, and the results become even more powerful.

Already I can hear the naysayers howling: From 2000-2008 the market wasn’t anywhere near a 10% return. True enough. But from 1982 until 2000 returns blew past 10% and averaged around 18% per year. Since the Spring of 2009 the market has just about doubled. The fact is, in any given year, it is exceedingly rare that the market will specifically return 10-11%. But that’s not what we’re saying. 10-11% is the average we can expect over a 20, 30 or 40 year span. Each individual year will vary wildly. Which, as we’ve said before, is why you gotta be tough.

Moving on, if we use your current savings rate of 24% you’ll have $16,800 to invest each year.

Your 403 (b) gets 3% of your $70,000 salary. $2100. (The university will add 2.5%, $1700, but that’s in addition to your 24%/16.8k investment money.) This will go into VTSMX and then to VTSAX when the balance goes over 10k.

Your Roth IRA gets $5000, also in VTSMX and moved to VTSAX once over 10k.

So between the 403 (b) and the Roth we’ve accounted for $7100, leaving $9700 to invest. Because you have the 35K, I’d put this into VTSAX in the tax advantaged SRP (Supplemental Retirement Program). For somebody without anything outside of tax advantaged accounts, I’d split it so some money is available without penalty in an “ordinary bucket” account.

Option #2, 50% savings rate.

Again you start with the $35,000 from your grandparents, but now from your salary we have another $35,000 each year to invest.

As before your VTSMX403 (b) gets 3% of your $70,000 salary. $2100. This is the max you can contribute. (The university will add 2.5%, $1700, to that but that’s in addition to part of your 24%/16.8k investment money.) This will go into VTSMX and then to VTSAX when the balance goes over 10K.

Your VTSMXRoth IRA also still gets the max at $5000.

So between the 403 (b) and the Roth we’ve again accounted for $7100, but now leaving $27,900 to invest. With this we can take full advantage of all the options your employer offers and max out the tax advantaged SRP (Supplemental Retirement Program) with $17,000 into VTSAX.That leaves $10,900. We’ll add that to VTSAX in the Ordinary Bucket and build on $35,000 seed capital your grandparents so generously provided.

Psst. He’s going for Option #2.

Finally, let’s talk about how these contributions will happen.

To begin we’ll take a look at Dollar Cost Averaging. Simply speaking the idea behind DCA is that if you invest a given amount of money on a regular basis over time the effect will be to have bought shares at a lower average price. This is because when prices are high your money will buy fewer shares than when prices are low.

For example, suppose we decide to invest $100 per month in XYZ Enterprises:

If my math is correct, we now own 50 shares of XYZ @ $8 per share on average. Thus we have avoided paying $10 a share had we bought all at once. Of course, some will argue that had we waited a month we could have picked up the shares at $5 each. But this would have required our knowing they’d drop to that level (before bouncing up to $15) in our example.

There is much debate on the usefulness of DCA and for any readers who might care you can click on the link. Moreover, it only really applies if you have a lump sum to invest. My preference, with a lump sum, is to invest all at once. I can’t be sure prices will move down to my advantage and if I DCA the money waiting is sitting in cash (or some other asset class) effectively altering my plan. I want my wealth building phase to be fully engaged with the most powerful asset class of all: Stocks. This is what I am suggesting for your lump sum of 35k.

Like most people, you’ll also be investing as you can over time. Effectively DCAing. You’ll be doing that with your 403 (b), SRP and Roth accounts, as well as any additional money you add to your Ordinary Bucket VTSAX initially filled with the 35k.

The beauty of your 403 (b) and SRP accounts is that once you set them up, the contributions will happen automatically. The Roth and Ordinary Bucket VTSAX will require you to expend a bit more effort. You’ll either have to add to them just like you pay your bills or you can set it up with Vanguard to have the money automatically transfer. Automatic’s what I’d do.

There you have it. Follow this….

…simple path…

…and before you know it you’ll have F-You money and working will be an option. By the time you are your grandparents’ (did I mention you should take them to dinner?) age you will have provided seed money accounts for your own grand kids, continuing the cycle. Around then you might also consider learning how to give like a billionaire.

Enjoy the journey and check in once in a while and let us know how it’s going.

60 Comments

You are the best teacher when it comes to personal finance, my friend. This is why I think blogging is a noble hobby. How otherwise a smart, young man can get advice from one and only one Jim Collins? I think every young person ought to read this.

This really needs to be passed around to everyone we know who’s looking to invest! KLR has some amazing options, of course, which not everyone has (unfortunately, I’ve never had a 401K or 403B with employer match, or such a high salary) but to be getting good advice at a young age is huge. You’re really helping a lot of people, including me. Thank you for that! But may I ask, why didn’t you recommend any REITs? I’m just curious, because I know that’s part of your strategy, and I would expect it to be a good idea for someone young (so I was planning to invest that way myself, in addition to VTSAX.)

And on a very different note, I noticed some watermarks on your images. I know you’re relatively new to blogging, and I thought you might get some use out of this post on using images on blogs. Personally, I’ve made a lot of mistakes on my own blog, and I now need to go back and remove/replace photos. It would have been easier if someone had clued me in sooner, so I hope that if you have any problems, you’ll be catching them early enough. And if this isn’t a problem for you, then congratulations on figuring it out early on.http://www.smartpassiveincome.com/how-to-find-images-blog-guide/

Thanks Jim. Great advice. It took me two reads, but I understand everything that you suggested. I have a lot of work to get to and I’ll make sure I keep you updated on the progress and will definably reach out when I have other questions.

Also, I call my grandmother regularly and talk about investments. Usually it is about current situations. I will make an effort to talk about what she did in past and there will for sure be a dinner coming to her very soon. Thanks everyone.

I’m in a position not far off from you. I graduated college at 26 and got a job making about the same as you, except I had student loans and some credit cards to pay off. About 5 years later I’m out of debt and and so far at a 50% savings rate for the year (although I’m shooting for 65%).

As most people and Jim has said, your greatest asset in this is time. I’ve been following Jim’s writing for a few months now and so far it hasn’t done me wrong (my only problem is I had to buy the investor grade VTSMX instead of the admiral. But will switch over after I clear the 10K hurdle). Good luck! Please keep us updated on your journey.

Great question and I probably should have touched on traditional deductible IRAs in the post. So, let’s take a look.

First, there is no IRS regulation that would prevent KLR from adding one to his mix. Like with the Roth the contribution is limited to $5000.

However, IRA deductibility for single people begins to phase out when income hits 58k and is gone by 68k. At first glance, his 70k salary seems to put him over the limit.

But….

With Option #1 his $2100 403(b) and $9700 SRP contributions push his taxable income down to $58,200. Throw in his Fed tax standard deduction and personal exemption and he’s well under 58k and eligible.

But…

We’ve used up his 24% investment money target and still have $7300 more SRP available. So the IRA isn’t needed.

But….

If he selects Option #2 it gets more interesting. Now we have 35k to invest. Even after fully funding the 403(b), Roth and SRP we still have $10,900 left. So what do we gain if we take $5000 and fund a regular IRA?

There are two downsides.
1. Given the kind of net worth KLR is poised to create and the likely increases in his income over time, in a few years he may never again see a 15% tax bracket. Remember, IRAs don’t eliminate taxes they only postpone them. It’s worth thinking about what bracket you’ll be in when the time to pay comes.

2. Should he wish to access this money before age 59.5 he’ll pay penalties on top of taxes. Since he already has the 35k to access, in KLR’s case I’d not much worry about this. But for a commentator like SFL below it would be a real concern.

Since KLR already will have a 403(b), Roth and SRP, and since he is in the 15% bracket, I figure he’s got the tax advantaged accounts covered. The added flexibility of the “ordinary bucket” might out weigh the immediate tax savings of adding the IRA.

But….

There’s really no bad choice here. And now KLR has another possibility to consider! It’s a beautiful thing. 😉

I am in a similar situation (25 years old, $25K Roth IRA, $15K in a 3% checking account $20K cash, making $40K a year) Where do you keep your F-You money? Is that in an ordinary bucket? Also, I am holding a lot of cash right now do to the possiblity of buying a house in the next 2-3 years. Do you have any advice on a better way to allocate the money I have at this point? I am wary of keeping so much cash and losing out on potential gains.

All your investments combined are what constitute your F-You money. So right now it looks like you’ve got 60k worth already. Great start at only age 25!

You are holding a lot of cash right now and if you are seriously planning to buy a house in a couple of years, cash is where you want it. That’s tough I know, with cash earning nothing these days.

As powerful a growth engine as stocks are, they can be very, very volatile. They are for long-term investing. think 10+ years.

The bigger question is do you really want/need a house? That is a very personal question and only you can answer it for you. But they are very expensive to maintain and rarely a good investment. At least, before you buy, run the numbers. I show you how here:

I was reading some articles about investing in mutual funds and timing your investment to avoid being hit with an immediate tax bill after receiveing distributions (http://invest-faq.com/articles/mfund-distrib-tax.html). How would you approach investing the $20K at this time? Would you invest it all in one lump sum or try to dollar cost average any of it?

I am leaning towards putting it into the VTSAX fund, but want to make sure I don’t take a loss immediately by missing some key piece of information. Typically I am very conservative with my funds so although I do believe putting money into VTSAX is the smartest long term option I am also trying to work past my conservative hesitations.

Thanks again for all of your great articles and your responses to the comments. This has quickly become my favorite financial blog and I’m looking forward to continuing to learn here.

The article you linked makes the point that buying fund shares just before a distribution of capital gains and/or dividends will increase your tax bill. Assuming you are holding the fund in a taxable account, this is true. Here’s why:

Anytime a fund pays out cap gains or dividends two things happen…

1. the value of the fund falls by precisely the amount of the payout.
2. these distributions are subject to taxes.

It is easy to miss the effect of #1 as the change in value of the fund due to the day’s market fluctuations tends to mask it. BTW, this is also true of dividend paying stocks and it is why proponents of dividend investing strategies tend to fool themselves into seeing dividends as “free money.”

So if you buy shares just before a distribution you are picking up the tax liability. If you buy just after you avoid it. Assuming distributions are reinvested, there is no change in the value, other than normal market fluctuations.

Since most cap gain distributions happen in late December, this can be avoided by buying in early January, or any other time.

If the fund is in an IRA or other tax advantaged account, none of this matters.

The bigger question you ask is how to invest 20k and, in a sense, you are asking if there is a way to time the market so you avoid a sharp drop just after you put your money in.

You can switch on CNBC and you’ll find no end of ‘experts’ who will tell you the market is headed up between now and the end of the year. And no end of those saying it’s headed down. Truth is, no one knows.

But it doesn’t matter. The money you’ll be investing will be in VTSAX for decades. What ever happens in the next few months will only be a blip on the chart by then.

When I have money to invest I wanted working for me as hard as possible as soon as possible. I push my chips in. If I take a short term hit, so be it.

If you are uncomfortable with that risk, using DCA is fine too. The important thing is that you are investing!

Hi Jim,
I have been reading your blog over the last 6 months. I look forward to new articles all the time and I really like your investing articles. I think your articles spell out the investing process better than anything I have read and in far fewer words. I think many people will end up much better off as an effect of you writing those. Thanks!!

I have also read a bunch of investing books by the Bogleheads, WIlliam Bernstein, and David Swenson and also the classics like The Intelligent Investor. You espouse 100% domestic stocks during the accumulation phase, but I have had a hard time buying into this.

For context to my questions, I am 26, save >60% of my after tax income, and I am an mechanical engineer who deals with statistics and math all day and I am very passionate about personal finance. So, a slightly more complex plan does not scare me. But, I am also worried, I might overestimate my abilities in this area and over think and overcomplicate things. At the very least I have bought into never picking individual stocks. But, I still find myself tempted to tinker from time to time. So, I want to find a plan I can stick to through thick and thin and not be tempted.

First, I am curious how you feel about holding an international index fund as well. The bogleheads and almost everyone else swears by this. Of course, the US total stock market is international. But, what about long periods where VTSAX is flat but VGTSX is not? I would bet that over the next 50 years these two funds will have similar returns, but not every year or 10 years. Recently, I have found I can stick to my strategy better if I see at least something going up. Am I crazy to think this? I feel like everything in one fund will really test my nerves especially early on when I have little emotional investing experience.

Second, I would like to get my FU money around 35-40. I think I am on track to do this I can do it with ease pending any major life changes (which will most likely occur, but who knows). But, I also think 100% US stocks may not be the best thing to reach this in a sub-20 year time frame. I think the optimal strategy for this goal would be a diverse portfolio like David Swenson’s Ivy or The Permanent Portfolio (which I think is overrated), for me, I like a variant on David Swenson’s:

45% VTSAX
20% VGTSX (international index)
10% VGSIX (Reit index)
5% Cash (In Ibonds mostly for a house downpayment if I go that route, might switch to gold if it ever gets to a record low again)
10% TIPS (I am holding Ibonds right now for this since my total portfolio amount is fairly small)
10% Vanguard Total Bond Market

With this I will most likely always be holding the “magic bean” as you put it. I also think I will not be to emotionally irked at any one time.

Am I going about this all wrong? What advice about how to approach investing would you give someone in my situation?

Your comment makes me smile because you raise great questions and you mostly have answered them yourself.

My short answer is: You are not crazy, you are going about this just fine and you are cautious about the right things.

As I said early on in the post, it is for people with little or no interest in investing. It is the Simple Path.

And as you said about yourself: “I am very passionate about personal finance. So, a slightly more complex plan does not scare me.”

You are right to be concerned about overestimating your abilities, over thinking and overcomplicating investing. Those three are a good overview of how most investors bring grief upon themselves. So you’ll want to control that temptation to tinker.

Don’t feel bad. I have it too. It is one of the prices paid for learning about this stuff. As I’ve confessed elsewhere I still, shame on me, occasionally buy individual stocks. I don’t talk about it much because it’s a bad idea. Kudos for resisting this.

OK. International Funds. You are correct that most investors swear by them, while I’m comfortable with the international exposure provided by VTSAX.

They also prefer, as you point out, a diverse portfolio of funds: Stocks, Bonds, REITS, Gold, Commodities and International versions of each. Simple v. complex.

It’s important to understand the goal of diversification is to smooth out the ride. As you said:

“I have found I can stick to my strategy better if I see at least something going up. I feel like everything in one fund will really test my nerves…”

Most people feel this way and if you are an actively engaged investor you’re likely to feel it even more. You’ll be looking at that volatility every day. That can scare the crap out of you.

But like everything in life, that smoother ride has a price. The research shows that stocks are the most powerful asset class for growth bar none. And one of the most volatile. The further you diversify away from them the smoother the ride and the lower the performance.

For me, the superior growth of a 100% stock allocation is worth the wild ride along the way. For an investor who is uninterested in investing and isn’t going to drive themselves nuts watching CNBC, just putting money into VTSAX over time will get superior results.

I give you big props for understanding your own investment psychology so well.

The portfolio you describe does complicate things a bit, but the important thing is it still uses low cost index funds and it will be more comfortable for you to live with. Of course, being more complicated you’re going to have to track these funds and rebalance on occasion. But that will be fun for you.

My bet is 20+ years out it will be a bit behind VTSAX, but you’ll sleep better and be more likely to weather the inevitable storms.

You’re saving 60% of your income, you’re investing in solid low cost funds and you’ve come up with a strategy that suits you. No one can argue with that. Well done!

I just recently started reading your blog and as others have stated you lay things out in very nicely, I love the blog. I like other users above have some questions I was hoping you could help me with.

I’m currently 29, married with our first child on the way. We have ~35k cash, ~18k in IRA/Roth IRA accounts with a financial advisor(paper work already filled out to move it to vanguard since reading your site), a Roth 401 option through my employer matching 6% which I’m contributing 6% with about $8k in the account and ~30% equity in our house. We have ~97k left on our mortgage @4.5% and we are going to be refinancing soon. My parents also max an IRA in my name that is invested in money markets that currently sits at about 35k and growing. I don’t control where this is invested. We currently save ~40% of or after tax pay with a net household income of ~70k pre tax.

My question comes into play with how best to use our 35k cash fund we have. My wife is not comfortable with going straight into the VSTAX. She wants to see how we do with the money we are currently moving to Vanguard does before we invest very heavily in Vanguard funds. While I understand her apprehension, I understand that it’s about the long ride and the sooner you can get compound interest working in your favor the better. That said it’s not a battle I’m going to win so that brings me to refinancing. We have a couple of options.

1) Go to a 20 year loan pay the mortgage balance down ~10k-closing costs to lower our payment to where it is now, thus saving us 8 years of payments. (rate 3.375%)

2) Same as option 1) only sticking to a 30 year, saving us ~$120 a month which can be used to pay down the mortgage faster or investing the additional saving in VSTAX (rate 3.5%)

3) Go to 20 year keep the principle the same pay an extra $50 a month and hold on to the 10k until I can convince the wife Vanguard is a good thing.

4) Same as option 3) only we save $~80 a month which would just continue to accumulate until I could convince her.

With the savings above to divert some of the additional money I could up my contribution through my employer to at least get a little bit more of our money invested.

I look forward to your opinion, thank you very much for your blog it is VERY informative.

If I understand correctly you have 70k sitting in cash. 35k in the IRA your parents control and 35k you and your wife have.

In the current environment there are two problems with cash:

1. Almost no return.
2. Risk due to a loss of value to inflation over time.

But the one is up to your parents and the other needs to be invested in a way your wife is comfortable with. That’s more important than money.

I would suggest to her that waiting to “see how we do with the money we are currently moving to Vanguard” won’t help. Here’s why:

VTSAX and the stock market are volatile. Let’s say you decide to give it a six month run to see how it goes. Perhaps after the time has passed the market will have had a strong run. It looks like, Holy Cow this is the ticket!!

Or maybe it takes a dive and you conclude, Boy Howdy this is no good.

Both would be wrong. It takes a 10+ year horizon and even then it can be misleading. 2000-2010 were very bad. Ironically that increases the chance 2011-2020 will be very good. The market is nothing if not cyclical.

I totally hear you on the market being crazy and cashing getting devalued. I think it’s only going to get worst post QE3, but no one really knows the future. At the moment the 35k cash is available, but it also includes emergency fund. She is comfortable using 10k towards refi and paying down the principle leaving us with a very large cushion.

I’m glad you brought up a mixed fund for a smoother ride. The issue is QE3 did not have a deadline put on it so isn’t it going to be extremely difficult to predict when interest rates are going to rise and the bond market is going to tank? Would you consider VBIAX a better option then paying down the mortgage quickly?

The quick version is I can put aside up to 15% of my salary to purchase company stock annually. Under the following terms:

The Employee Stock Purchase Plan gives you the advantage of purchasing company stock on a quarterly basis through payroll deductions at a discount of at least 15% based on the stock price at the beginning or the end of the purchase period, whichever is lower.

She just has a mother that sees the worst in every possible situation. We actually had a really great discussion tonight where I brought up many of the points you stated in this blog. I think it’s just a matter of time until she becomes more comfortable. With a baby on the way and our monthly budget going into the unknown once the baby gets here I can understand her apprehension. The only real expense we know for sure is daycare is going to be an eye popping $209 a week!

Hi Jim,
Here’s a question I’ve had in the back of my mind when I read about IRA investing. I understand traditionals are taxed later while Roths are taxed now, where it is wiser to invest in a Roth at a younger age under the assumption that your later-years tax bracket will be higher.

I’m 26, single, no dependents, and I have an income of $130k/year, which puts me in a pretty high tax bracket right now. I don’t expect my income to climb oh-so-much higher over the next twenty years. Is it still advisable to use a Roth over a traditional?

Hi Micheal, I’m current in college and I’m currently actively looking for a career that would place me in a bracket such as yours… How exactly did you make to where you Are and if you don’t mind me asking what do you do?

What a wonderful post! I can’t say enough great things about your blog – I’ve learned more here in a morning of browsing than on any other site or with any other book. I’d love to get your opinion on my situation.

For background purposes, I’m 33, single and my income is around $80K per year. My goal for 2013 is to contribute the $17K max to my 401K which my employer will match 50% up to 6%. I’ll also max out my Roth and put any remaining money into a taxable account. I’m aiming for a savings rate of 60%. You’ve sold me on VTSAX and I plan to hold that in my Roth as well as a taxable account for anything additional.

My question is about my 401K. I unfortunately, don’t have a Vanguard option here. It’s with Principal and it doesn’t look like there is a total market index fund offered. However, there are large, mid, and small cap funds offered. Should I just select the large or is there a certain percentage combination of the three that I should be using?

Also, at 33, is 100% in stocks too much? I’m ok with the fluctuations and know this is for the long haul, but I’m not sure if that’s too aggressive.

You are off to a great start and that impressive 60% savings rate is far more important than which fund you choose for your 401k. Well done!

The next most important step you should take, if and when the time comes, is to be sure your chosen spouse is on board. Little is more potentially damaging to relationships than money.

As for the 401k and the small, medium and large cap funds, the truth is that it is a coin toss as to which will provide the best return over, say, the next 30 years. If you can easily split the money among all three, that’s like having a total market index fund. If one has significantly lower costs than the others, I’d go there.

100% stocks is VERY aggressive and is, IMHO, exactly right for a 33-year-old with a 30 year retirement horizon. Provided you are tough enough to stay the course and not panic during the hard times you will certainly experience over those decades.

When you start to consider retirement, at whatever age, you’ll want to look at adding bonds and REITS.

What an awesome blog! I have learned so much since reading a bunch of your articles this past week. In fact, I’ve already changed my 401k portfolio to something way more aggressive as I’m 28 with a 30 yr retirement timeline.

I am curious however as to why you didn’t recommend maxing out the 401k before starting a separate SRP when they are both invested in the same index fund.

Also, my employer doesn’t offer a TSM index, only an S&P 500 index with a 0.3% ER. Should I just contribute enough to get the full 401k match and then open a Vanguard Roth and max that out in VTSMX/ VTSAX with the cheaper fees? If I have more to invest after that should I add more the my 401k or open another (SRP im assuming?) account to continue to invest in VTSAX?

Thanks again for this blog. I’m looking forward to the time I can give some big F-YOU’s to some well-deserving people!

You could max out the 401k first. The important point was to fund it up to the max match and then move to the Roth. For you it might look like this:
401k up to match
Roth
401k maxed out
SRP, if offered

An S&P 500 Index fund is a fine proxy for a TSM index. No worries. My guess is the TSM will out perform over time but the margin will be small. And it could go the other way. Nothing to lose sleep over. Most of this is details.

The key is an aggressive savings rate, stock index fund investing and taking advantage of tax deferal opportunities. Sounds to me like you’ve got it covered. Good job.

Thanks for your wonderful blog, Jim! I came here from MMM and your writing is a true gift to all of us out here with little or no understanding of investing. I just finished reading your stocks series and, to echo what many other commenters have posted, it was a true education.

I’m a federal employee and have been maxing out my Thrift Savings Plan (the fed version of the 401k) for several years now. My wife and I had some extra cash and fully funded a Vanguard Roth IRA for 2012 and 2013 earlier this year (Target Retirement funds for each). Also started investing in VTSAX this year as well, so we’ll see where that takes us down the road.

I’m 37 and my wife’s 32, so we have some time on our side. We are intrigued, however, by the “smoother” path to wealth, investing in Vanguard REIT and bond index funds. We have a small (like 10% of the overall in the Roths) in bonds, but haven’t invested in any individual taxable REIT or bond index funds. Any thoughts on when we might want to add those to the portfolio? I’m planning to “retire” by 50 (I always seem to find work, even if I don’t really want it!); my wife may work a bit longer. Thanks again for your great efforts… this blog is truly a joy to read!

As to when you should add the REIT & Bond funds, it depends on your tolerance for risk. I would certainly have them in place three years before you plan to hang it up. Now is not too soon if it would make you feel more comfortable.

Remember, if you are investing in TRFs (Target retirement funds) you already have a bond position. Just how big it is depends on which TRF you’ve chosen. When/if you decide to add a bond fund, be sure to take that into account.

Jim – I just found your blog through MMM comments . . . I’ve been poking around on here and I want to say thanks for the great posts and follow up comments! I’m 34 and finally maxing out my 401K contributions this year and will be able to max out my Roth next year as well. In the next few years, I will start working on my ‘other’ savings strategies and it’s so great to read about my options for doing this. Thanks again!!

I to also have a question… Ok I’m 19 .. yes very young but I’m making pretty good money as a college student and I want to start early making the right investments so I can thank myself later… Ok my finicial situation I currently make about between 2,000/ 1,400 a month after taxes and a anual salary of 27,900 a month..as far as bills only 200 of that goes to bills and about 250 goes to savings so that leaves me roughly a 1000 a month to play with and I want to invest… Where should I start.

First, let me say that I love your blog. I discovered it about a month ago, and my head is spinning from all of the advice and wisdom!

I am 29, married with two kids, my wife is stay at home and I make about 85K a year. Unfortunately, due to some poor spending habits we’ve only now gotten started on our pursuit of F-U money. But i want it badly now, and my goal is to hopefully have it by the time I am 40 or 45.

However, even though we loved spending our money, we’ve never gone into debt- so no mortgage (yay!), no car and no credit cards. And now we’ve bumped up our savings rate from 0% to 50%. My employer is a small business that offers a SIMPLE IRA- so i’ve started maxing that out at 12K per year (with a 2% match). Its through Fidelity,which doesn’t offer Vanguard funds, but i’m putting the funds into “Fidelity Asset Manager 85%” which seems to be the closest thing to an index fund they offer. From what I’ve been reading, after 5 years, I can roll this over into something else if I choose.

I’m also maxing out an HSA since we have a high deductible health insurance plan- that’s another $6,450 a year. What’s sweet here is that I can also invest these funds, and am doing so through TD Ameritrade, into a Vanguard Total Stock Market ETF.

That leaves me with around an additional $1,200 a month to invest after taxes. I set up a taxable account at Vanguard and have been putting it into VTSMX, which i’ll roll into admiral shares once it reaches $10,000.

We also have 5K sitting in a savings account as an “emergency fund”.

I figure that I will fully invest into my SIMPLE IRA and HSA for the next 8-9 years, then stop, letting those accounts ride for the next 20-25 years. Then, i’ll take the money that was going into those accounts, top off my taxable investments for another 4-5 years, then hopefully let the good times roll.

Considering my goal of FI in the next 10-15 years does this strategy seem sound? I’ve been debating whether i should also open up a Roth IRA and allocate savings into that but i’m wondering if I should tie up so much of my investments into “old man money”.

I was also thinking of taking that 5K in savings and putting it into VBINX so that our short term, emergency stash, does some working for us, as opposed to sitting around doing nothing. I’ve been debating if we need a larger emergency stash then this, and if we should keep it under the mattress (i.e. a savings account).

–Fidelity Asset Manager 85% is an OK fund but has a pricey expense ratio of .82%. Fidelity offers a fine line of index funds they call Spartan. Most company sponsored plans that use Fidelity offer these. If yours does, I’d switch to the Total Stock version and it will have an ER of about .05%.

–Awesome on the HSA.

–Awesome on VTSMX. You won’t even have to do anything when it hits 10k. Vanguard will upgrade you to VTSAX automatically.

–You should continue to fund your SIMPLE IRA and HSA as long as you are working. I think that’s what you are saying?

–Definitely open the Roth and fully fund it. These things are just too good on too many levels not to take advantage.

–VBINX is a fine stock/bond 60/40 fund, but again a little pricey on the ER. Around .24% if I recall. But this is for long-term investing and is not the place for emergency cash.

–Like you, I hate to see my cash lying around in the sun drinking pina-coladas and doing no work for me, but your FDIC insured bank is the place for it.

Finally, let’s talk a bit about your concern of having not enough in taxable accounts to draw on once you retire. At $1200 per month you’ll be investing $14,400 a year into taxable accounts. Funding the Roth will take that down to around $9000 which will grow to a tidy sum over 12-15 years.

Of course, the later you retire the longer it will grow and the shorter the gap between hanging it up and 59.5. Plus, even after retiring you might still occupy yourself with some activities that bring it some income. In other words, things will be clearer closer to 40-45. Remember too, that you can set up penalty free IRA withdrawals earlier than 59.5. It is a bit of a pain, but doable. Don’t worry about it for now.

Two things you might do:

1. Wait until you are around 35 and see where the taxable account stands. If it looks too small, you can begin diverting more funds to it then.

2. Pull out your tax return from 2012 and do a little analysis. Myabe you don’t need to put the full 12k into the IRA.

Making 85k, less the IRA 12k and HSA $6450, less the $11,500 standard deduction, less the 4 exemptions for you, your wife and two kids — $15,200, your taxable income is $39,450. That’s below the $41,952 income limit (married with 2 kids) for the EIC (Earned Income Credit), which is a very sweet cash gift from your Uncle Sam.

My guess is that with all this your tax liability is going to be very low. Play with the numbers, making sure you don’t lose the EIC, and see if you are really getting any tax advantage to the full 12k IRA contribution. It might be you can shave a bit off to build your taxable account with no tax hit.

Thanks for the input on the Roth IRA. I was pretty much going in that direction but you definitely convinced me. My thought is that i’ll just fund my IRA with the same thing i’ll fund my taxable accounts with- good ole VTSMX. At some point i’ll introduce some REITs and Bond funds to the equation once i reach the “wealth preservation stage”.

Thanks again for your advice! I can’t tell you how much this blog as changed my outlook and attitude. Before I found this blog and MMM i was convinced i’d be working until i dropped dead someday just because that’s basically the mindset of everyone i know and work with. Now, i have a ton of optimism about the future and feel like I actually have control of it, which is a great thing.

As you and everybody who reads this blog knows, I recommend Vanguard as it is truly the only investment company that puts its customers best interests first. Competition has forced companies like Fidelity to offer a line of low cost index funds and that has allowed me to soften my view on them, especially if Vanguard is unavailable for some reason. But I’ve always cautioned their heart wasn’t really in it and they only served up low cost funds when forced to and as “loss-leaders.”

But clicking on the link you just provided, I am truly appalled. Not only is the list of funds almost endless and confusing, they are all “Class T” where as far as I can tell “T” means “Take lots of your money”

As high as .82% is for an ER, at least it is the only fee. But in your IRA they don’t offer you this class of the the fund. They force you into their “T” class. Here’s a look at that and the related fees:

This is nothing short of a money grab on Fidelity’s part and shame on your employer for not better protecting your interest.

All of this is enough for me to seriously suggest you skip investing in your 401k all together. Here are the three things that you might want to consider before you do:

1. Does you employer offer a match? A match with offset these horrible fees, so you might still invest but only up to the full match.
2. Are you in a really high tax bracket. 25%+. Even without your 401k, you are not.
3. Does the 401k get your income below $41,952 for the EIC as we discussed.

Finally, In the comment section under Part IX of this series reader Prob 8 posted:

“If anyone doubts JLC’s claims regarding the impact of fees and commissions on your portfolio, please check out this video from PBS:http://www.pbs.org/wgbh/pages/frontline/
It’s called The Retirement Gamble. There are interviews with Jack Bogle and all you’ll need to know to realize fees and investment advisors are hurting your portfolio more than helping.”

I just finished watching it. Very powerful stuff that in part speaks to excessive 401k fees. I highly recommend you and other readers here check it out.

Thanks Jim. I checked out that video and its crazy stuff. Gave me all the motivation i needed.

I’ve been working on this today, and may actually have some options I didn’t know existed. It looks like I can place my SIMPLE IRA investments into a Fidelity run money market, which has significantly lower fees. Then- as it turns out, i might be able to set up a “stand alone” SIMPLE IRA through Vanguard which can then receive automated transfers from my Fidelity money market account- which would of course go to our friend VTSAX. I could set this transfer for every two weeks and Fidelity would charge $0 in transfer fees.

I still have some hoops to jump through but i’ll report back and let you know if I’m successful.

Jim, Your blog has opened my eyes, and you have convinced me to put my future contributions in index funds. I have a couple of funds in my 401k (JVMIX and RPMGX) that have great long-term (10 year) track records. Could these be in the 20% of managers that earn their fees? I’m tempted to transfer them to VTSMX. VTSAX is not available in my plan according to Fidelity. Thanks!

I am unfamiliar with the two funds you mention, so I have no idea if they are currently in the 20%. But it doesn’t matter. The 20% is continually changing. So even if they are now and have been for the last 10 years, it is meaningless. Their past has precisely zero predictive value. As Jack Bogle says, performance is fleeting, fees are forever.

VTSMX is exactly the same total stock market index portfolio as VTSAX. If it is available in your 401k it is what I would choose.